Commentary
About the data
Definitions
Data sources
World stock markets are booming
During 1990–95 world stock market capitalization rose from $9.4 trillion to $17.8 trillion, and developing economies increased their share in this capitalization from less than 4 percent to almost 8 percent. Emerging markets also saw an increase in the value of shares traded—from 3 percent of world trading in 1985 to 9 percent in 1995.
Part of the impetus for this growth has come from market liberalization. As these relative newcomers on the global economic stage have become more integrated with established world capital markets, they have reformed laws and regulations and removed capital controls and other barriers to foreign portfolio flows. Investors in industrial countries have responded with a substantial increase in portfolio flows to these markets (see table 5.2).
Opinion is divided on the importance of stock markets to economic growth. Some analysts view stock markets in developing countries as "casinos" with potentially negative consequences for growth. Others argue that stock markets have a positive effect on economic activity through the creation of liquidity.
Many profitable investments require a long-term commitment of capital, but investors typically are reluctant to relinquish control of their savings for long periods. Liquid equity markets make investment less risky and more attractive because they allow savers to acquire an asset and to sell it quickly and cheaply if they need access to their savings or wish to alter their portfolios. At the same time, companies enjoy permanent access to capital raised through equity issues. By facilitating longer-term, more profitable investments, liquid markets improve the allocation of capital and enhance prospects for economic growth. Further, by making investments less risky and more profitable, stock market liquidity can also lead to more savings and investment. Investors will come if they can leave.
But an increased return on investment may reduce overall savings, and reduced uncertainty may reduce precautionary savings. And since investors can leave when they want to, they may not bother to stay and exercise their rights as shareholders to improve corporate governance. Nevertheless, recent work suggests a strong correlation between stock market development and long-term growth (see the May 1996 issue of the World Bank Economic Review).
The level of stock market development in an economy is closely related to its overall level of development. At low levels of development, commercial banks tend to dominate the financial system. As economies grow, specialized financial intermediaries and equity markets develop.
Stock market size can be measured in a variety of ways, each of which may produce a different ranking among countries. Market capitalization in U.S. dollars gives the overall size, and the ratio to GDP the size relative to the economy. Market size is positively correlated with the ability to mobilize capital and diversify risk.
Market liquidity is measured by dividing the total value traded by GDP. This indicator complements the market capitalization ratio by showing whether market size is matched by trading. The turnover ratio—shares traded as a percentage of market capitalization—is also a measure of liquidity as well as of transactions costs. (High turnover is an indication of low transactions costs.) This indicator also complements the ratio of value traded to GDP, since turnover is related to the size of the market, and the value traded ratio to the size of the economy. A small, liquid market will have a high turnover ratio but a small value traded ratio. The number of domestic companies listed is also a useful indicator of the size of stock markets.
The price-earnings (P/E) ratio measures the current price or value of a stock divided by its latest earnings distribution. The average P/E ratios in the table are based on the International Finance Corporation's (IFC) Global Index for each market, and represent the market capitalization of the index divided by the earnings of companies in the index. (Average P/E ratios are unavailable for many countries.) If the P/E ratio of a stock is at a historic high, investors may believe that the price of the stock is likely to move downward, and the opposite if the P/E ratio is low. Thus the average P/E ratio is sometimes used as a leading indicator of the direction in which an economy is likely to turn.
• Market capitalization, or market value, is the share price times the number of shares outstanding.
• Value traded refers to the total value of shares traded during the period.
• Turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is calculated as the average of the end-of-period values for the current period and the previous period.
• Listed domestic companies are the domestically incorporated companies listed on the country's stock exchanges at the end of the year. Investment companies, mutual funds, and other collective investment vehicles are excluded.
• IFC Global Index price-earnings ratio is the total market capitalization divided by the total earnings of listed companies on a trailing 12-month basis. The ratios in the table reflect only the companies included in the IFC Global Index for each market.
Data are from the IFC's Emerging Stock Markets Factbook 1996. The IFC collects data through an annual survey of the world's stock exchanges, supplemented by information provided by Reuters and the IFC's network of correspondents. GDP data are from the World Bank's national accounts data files. The feature text is based on Demirgüç-Kunt and Levine (1996b).
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